This week, the chair of the U.S. Federal Reserve, Jerome Powell, caught the attention of money managers and bankers with major speech on monetary policy.
He explained that the Fed's Federal Open Market Committee has adopted a "revised consensus statement" to achieve inflation that averages two percent over time.
However, inflation could run "moderately" above that "for some time", Powell declared.
That marks a change from the traditional approach of trying to limit inflation to two percent.
And that could conceivably reduce the likelihood of higher interest rates if the economy gathers steam and prices start to rise.
While there's been considerable talk about the impact of Powell's comments on stock markets, less has been said about real estate.
"The persistent undershoot of inflation from our two percent longer-run objective is a cause for concern," Powell said in explaining the change. "Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy.
"And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes," he continued. "However, inflation that is persistently too low can pose serious risks to the economy."
Deflation becomes the bugaboo
Clearly, Powell is concerned about the prospect of deflation, in which prices start falling.
That can drive down demand as consumers and businesses put off purchases in the expectation of even lower prices in the future.
Deflationary pressures drove the Japanese economy into a hole in the 1990s as asset prices collapsed. The same occurred in the Great Depression of the 1930s.
"Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations," the U.S. Federal Reserve head warned.
Moreover, he said that "expected inflation feeds directly into the general level of interest rates".
In its May 15 Financial Stability Report, the U.S. Federal Reserve warned of the potential for "outsized drops in asset prices" due to liquidity concerns arising from the pandemic.
It even suggested that economic conditions could create "an incentive for investors to withdraw funds quickly in adverse situations".
"Facing a run, financial institutions may need to sell assets quickly at 'fire sale' prices, thereby incurring substantial losses and potentially even becoming insolvent."
The report noted that the value of all U.S. residential real estate is US$37.8 trillion. And this had shown average annual growth of 5.5 percent from 1997 to 2019.
The value of all commercial real estate in the United States reached $20 trillion in 2019 following an eight percent rise over the previous year.
"Property prices—including on commercial real estate (CRE), farmland, and residential real estate (RRE)—generally take more time to respond to sudden changes in economic activity but appear likely to come under pressure," the May report stated.
Interest rates affect home prices
So now, three months later, Powell has sent a signal that he'll be a dove on interest rates.
This could lower the likelihood of the U.S. dollar appreciating in value. And north of the border, that would mean less pressure on the Bank of Canada to hike interest rates.
But what does a looser monetary policy mean for home prices?
In 2014, economists Òscar Jordà, Moritz Schularick, and Alan M. Taylor wrote a paper looking at 140 years of data from 14 advanced economies to determine the impact of loose monetary conditions on housing markets.
"House prices, interest rates, and mortgage credit aggregates are jointly determined in equilibrium, and this makes establishing causality difficult," they acknowledged in a follow-up article on the Centre for Economic Policy Research's VoxEU.org website.
They noted that "broadly speaking", when a country pegs its currency to that of another country, it effectively imports that other country's monetary policy.
And they found that a one-percentage point decline in short-term interest rates, measured by three-month government debt instruments, can cause a spike in mortgage loans, amounting to about 0.5 percent of gross domestic product.
"Yet the effect of the initial shock keeps building over time, and by year four there is about a 3 percentage point increase in the ratio of mortgage loans to GDP," Jordà, Schularick, and Taylor wrote.
That, in turn, can lead to a four percent increase in the "house price-to-income ratio after four years".
"We have established that loose/tight monetary conditions make credit cheaper/dearer and houses more expensive/affordable," they concluded. "But what about the dark side of low interest rates – do they also increase the risk of a financial crash?"
Here, they concluded that the answer was also "yes". And they declared that the association was even stronger in the period following the Second World War when real estate loans assumed a greater share of banks' balance sheets.
"An important implication of our study is that macroeconomic stabilisation policy has implications for financial stability, and vice versa," they wrote.
Pandemic presents huge risk
Of course, in the midst of the COVID-19 era, central bankers are facing unprecedented challenges.
And tinkering with inflationary targets is easier to justify in what's been referred to as a "Pandemic Depression" by the chief economist of the World Bank.
We're in uncharted waters at the moment as a result of a monumental global economic contraction.
Yet in spite of this, home sales in Metro Vancouver surpassed historic levels in July.
And now, it appears as though the U.S. Fed is may try to put off raising interest rates even when inflation starts climbing.
If history offers any lessons, it could mean that even more people will be taking out mortgages—that is, if they can afford to do so.